Quaker Chemical Corp (KWR) 2005 Q3 法說會逐字稿

Welcome to the Quaker Chemical Corporation thirdquarter 2005 earnings conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Ronald Naples, Chairman and Chief Executive Officer for Quaker Chemical Corporation. Thank you Mr. Naples. You may begin.

Thanks very much, Dan. And welcome everybody and good afternoon. With me today is Neal Murphy, our CFO and as our usual practice we will both make some comments and then we will be available for questions should there be any when we are finished. You've all seen our thirdquarter press release by now; our sales are up solidly and our earnings are up dramatically over the prior year, both good feelings for us given the way it has been going this year so far. We continue to fight the good fight, which is beginning to show up a bit in our performance I am glad to say. I believe we are moving in the right direction in many areas, and we are making good progress in a number of important areas and I thought what I would do in a few comments is try to pick down those areas.

First, earnings results. Our third-quarter earnings per share were $0.23 as you know, and that shows real progress from the first quarter's $0.12 when you strip out the puts and takes of the charges and the real estate venture. Second quarter is $0.18 and now this quarter is $0.23 so a solid sequential improvement.

If you look at the performance versus last year's third quarter, it is almost a double. Last year we had $0.12 and this year its $0.23, of course that is a very low point of comparison, so I understand that completely. What is particularly notable about the third quarter comparison this year to last year, is that or I should say notable about our third quarter compared with second quarter's $0.18 is that this quarter is that the higher earnings was achieved on sales about 1.25 million lower than we had in the second quarter. So that goes to margins, and I will talk about that in a moment.

But the second area I want to point to, since we are talking about sales, is the fact that we did have a solid quarter in terms of a 6% sales gain. In fact, it was our highest ever sales for a third quarter. It was driven largely by increased volume in Asia-Pacific generally, and China specifically which continues to do very well. In fact, we continue to win virtually all the new cold rolling mill business coming online in China. So we're doing very well there.

We did see continued softness in a number of markets, both in metalworking and steel and particularly in Europe and the United States. But we did see some budding signs of our business getting a little bit better, particularly as the third quarter moves on a bit. Let me give you a brief world sweep to give you some sales performance context for how we're doing.

In steel in the third quarter cold rolled production was flat with the second quarter and in North America and Europe and South America. But the production was up 7% in Asia-Pacific, it was up 20% in China. And again, we were a beneficiary of that kind of increased production in China. Towards the end of the third quarter, as I mentioned, even North America and Europe showed some new life. Cold rolled sheet inventories have come down. North American inventory to shipment ratios were down almost 25% in the quarter from the kind of ratios we saw in the first quarter. And we saw some increased user demand in the United States which is a refreshing change for the year, and that was reflected in North American spot prices being up 20% in the quarter after being down almost twelve months straight. Even in Europe were the demand is not strong we saw some firming of cold rolled spot prices, which is a good sign for what may come.

In metalworking we did see major manufacturers with their inventories leveling out. The estimates were about 60 days in the third quarter versus a low of 35 days in July, which of course 60 days is building inventory. But it was off a high of 107 days in February. So you can see it's somewhere in the middle ranges. The European production was down a bit and it was done dramatically in Germany as a matter-of-fact. So, of course that has some effect on our metalworking throughput. We are still doing very, very well with the product sales to the automotive industry in the United States through our CMS penetration. Those numbers are up very significantly for the year, and where CMS is concerned we have also made real progress in trying to improve the economics of a few of our sites through some continuing negotiations with customers who have shown a willingness to work with us. So that's looking pretty good also.

So on the whole we see a pretty mixed sales picture. But the good news is that in spite of these soft times our sales are headed up. And I think this is really indicative of our gaining market position, the kinds of strong positions we've been able to build on and we think we're in an excellent place to gain from any improvements in the market environment going forward.

Third point I want to point to is margins. The third quarter saw our highest gross margins of the year at 32% versus a second quarter of 30.6% and the first quarter of 29.7%. So again, as in earnings, you can see that there is real sequential improvement through the year in quarterly gross margins. Even versus the third quarter of '04 we showed improvement from 31.8% to 32%. Now this is admittedly a very small improvement, but what is particularly notable about it is it comes at a time when the average crude price affecting the derivatives of crude that we use that average crude price was about $42 in the third quarter of '04 and for this quarter, third quarter of '05, that equivalent was $63. So even in the face of a 50% difference in our material cost, we were able to show some again admittedly small improvement in margins.

This is indicative of the continuing pricing work we have been doing with our customers to find ways to blunt the extraordinary effect of extraordinary external cost factors. In the course of these discussions with customers we've worked very hard to stay focused on how we deliver more value to them, even as we deal with these difficult market realities. Because at the end of the day, that is really the market position that we want to build with our customers as someone they can rely on to create better conditions for them.

We've seen some new interesting things on the cost front of raw materials. In addition to the effects of crude oil pricing, which in fact has come down a few dollars in the recent past, we are also feeling a new pressure in through the effects of refining capacity constraints for mineral oil. That is both in terms of the industry capacity being down versus the demand that is out there, and also the fact that refinery shutdowns and lower availability through other items -- strikes and maintenance and that kind of thing -- have also caused a squeeze in the market. So this has caused our mineral oil prices to actually exceed the kinds of increases we've seen in crude.

I've used the word extraordinary alot in these last comments, and I think the important point is that we will be working our way through these external cost factors. The fourth area I want to point to and now I am moving out of strictly third quarter events, is that as we deal with these extraordinary external factors we know it is important and we've taken steps all year long to work hard on internal cost factors. I think that is apparent in our SG&A numbers, which have shown very modest increases when you strip out onetime things and the effect of exchange rates. It is reflected in the smaller staff rationalization we announced in the third quarter for which we took a small charge then, and the work we have been doing on current internal cost factors is particularly reflected in the much bigger restructuring that we noted in our press release. We hope to lower our cost base $8 to $10 million a year. And you'll be hearing more specifics about this in the fourth quarter report. But suffice it to say that we know we need to be extraordinarily cost conscious in how we run our business.

Beyond cost we want to run our business more effectively in these tough times and for this we've moved to a much more regional execution to get closer line of sight performance and more local integration in going to our markets. At the same time as we make these kind of changes we want to retain all the global capabilities and strengths we've built because we believe strongly that one, our markets and our customers are getting irretrievably more global and, two, our global capabilities and global integration, which we believe are by far the best among our competitors, are the bedrock of our competitive differentiation. So while we think we're in an excellent position to gain from a change in market dynamics in the business environment out there, we also feel an obligation to make sure we’re doing things internally to buttress that from an earnings standpoint.

And the fifth point I will make is that we've put in place financing availability through the $100 million facility that we announced a few weeks ago, that we believe will be of great value to us. So, to go back to my original premise about moving in the right direction, we feel we are getting some momentum on our side. The sequential quarter-to- quarter earnings increases we see this year, even in the face of tremendous raw material cost pressures point to that, there is the glimmer of improved margins, there is the continual leading market position we have been able to build as we show sales increases even in these tough times, and major steps we're putting in place to further lower our cost base and there is the solid financing availability I mentioned. We know we have challenges remaining, and we know we have much further to go. Demand could be stronger, raws are still a wild card, particularly now with refining capacity constraints. We want to further improve our CMS contract arrangements to show better and to show better economic footing for us, at the same time we work with our customers to find ways that we can continue to create value for them, and we will really be pointed to this as we renegotiate the bulk of our contracts coming up next May. And of course, we know we have a challenge of getting the best out of our reconfigured organization and staffing focused on local execution, as I said. While we retain the competitive advantage of our global capabilities. Particularly the capability to deliver the best worldwide knowledge everywhere in the world from anywhere in the company that we have it.

So, all things considered, we have come through a very difficult period. We are realistic, and we manage with a firm grasp some of the facts rather than the way we hoped it would be, and we're committed to restoring the financial performance record that puts us back on the earnings growth track and of which we have been so proud in the past. So that is our focus going forward, and with that I will ask Neal to provide a bit more detail.

Thank you, Ron. Good afternoon, everyone. As you know, yesterday we announced quarterly sales of $105.8 million and diluted earnings per share of $0.23 for the third quarter of 2005 as compared to sales of $99.7 million and earnings per share of $0.12 in the third quarter of last year. I will focus on the drivers of third [company corrected after the call] quarter performance, put some of Ron's comments in the context of the P&L, and then we will open the floor to questions.

Revenues for the third quarter compared to the same period last year were up 6%. Of the 6% revenue growth for the quarter, approximately 2% was due to foreign exchange, with the remainder primarily attributable to higher sales prices. The foreign exchange improvement was primarily due to a stronger Brazilian real as the average rate was 0.43 this quarter and 0.34 during the third quarter of 2004.

The higher sales prices are a reflection of the Company's actions throughout 2004 and 2005 to mitigate higher raw material cost. As Ron mentioned, we had strong volume growth in the Asia-Pacific region, and this was substantially offset by softer demand in the Company's other regions, specifically the U.S. and Europe. While we achieved increased market penetration in Asia-Pacific during the third quarter, overall volume was flat in the face of continued production cutbacks at major steel mills in the U.S. and Europe. And this was due to a large degree to inventory destocking and softer end-user demand within our steel markets.

On a positive note, though, excess inventory levels in the steel supply chain in the U.S. have been reduced significantlyand as we move into the fourth quarter, they are approaching historical norms. Inventory reduction has also occurred in the Europe supply chain, although some excess still does exist. The 6% sales growth for the quarter is very consistent with our year-to-date sales growth of 7%.

Moving on to gross margin, the increase in sales combined with a moderate gross margin improvement resulted in 2.2 million higher gross margin dollars than in the third quarter of 2004. Gross margin as a percentage of sales was compared was 32% compared to 31.8% for the third quarter of 2004. This 32% gross margin percentage represents a continuation of margin restoration as the margins in the first and second quarters of 2005 were 29.7 and 30.6%, respectively.

Again the Company's pricing actions are driving this sequential quarterly improvement. And this improvement has occurred despite significant upward improvement in raw material costs, both for Quaker product and with regard to third-party product purchase costs under our CMS contracts.

As mentioned in prior conference calls, certain of our CMS contracts preclude Quaker from passing through these higher costs. However, as Ron mentioned, we're very pleased with recent progress made in this regard as we have obtained contractual concessions on some of our existing CMS contracts, and we've also won bids recently on new contracts and these bids include raw material price escalation protection.

While we're making progress in the gross margin area, we still have a ways to go. We continue to lag 2004 on a year-to-date basis by 1.8 percentage points as the upward spiral in raw material costs did not occur until late in the second quarter of 2004, where we experienced it for all of 2005. As Ron mentioned, crude oil prices seem to have stabilized in the fourth quarter after spiking to an average of $63 in the third quarter from $53 in the second quarter. However, we continue to experience upward movement in our mineral oil and downstream derivative raw material costs as refining capacity has been constrained by hurricanes and other factors.

Moving down the P&L, I will now speak to SG&A and other expenses. SG&A as a percentage of sales for the quarter at 28.3% is generally in line with the 27.5% rate for the first nine months of 2005. And it represents a very positive improvement over the 29.3% rate for the third quarter of last year. In absolute dollar terms SG&A this quarter is up 0.7 million compared to the 29.2 million reported in the third quarter of 2004.

Foreign exchange rate translation accounted for approximately three-fourths of the increase with the remaining increase due primarily to a charge of 0.2 million related to the Company's early repayment of senior unsecured notes due in 2007 and additional provision for doubtful accounts in connection with a customer bankruptcy, and inflationary increases. These increases were partially mitigated by continued cost reduction efforts.

Our upcoming restructuring is expected to reduce SG&A further as a percentage of sales as we seek to offset some of the margin deterioration driven by higher raw material and third-party product purchase costs. Higher net interest expense compared to the third quarter of 2004 was attributable both to higher average borrowings, as well as higher interest rates on the Company's short-term debt.

The effective tax rate for the third quarter is 32.5% versus 31.5% for the same quarter of last year. And minority interest was lower for the third quarter of 2005 compared with the same period last year. And this was driven by the acquisition of the remaining 40% interest in our Brazilian joint venture, which we spoke about in prior conference calls and which occurred in March of 2005.

I also want to make a few remarks on the balance sheet. In cash flows, the Company's net debt has increased from December 2004 primarily to fund the Brazilian acquisition noted above, as well as to fund working capital needs associated with our growth initiatives. Our net debt to capital ratio was 33% in September 2005 compared to 28% at the end of 2004. And in September 2005, we elected to repay our senior unsecured notes, which were due in 2007. On October 14, 2005, the Company entered into a $100 million five-year unsecured syndicated revolving credit facility. This facility will enable consolidation of short-term debt into a longer-term facility and will ensure liquidity to support future growth plans. This facility can be upsized to $125 million should additional financing be required in the future. And that concludes my prepared remarks.

At this time we will turn to any questions that you all may have. So Dan if you will facilitate that, please?

(OPERATOR INSTRUCTIONS) Brad Osleger, DePrince, Race & Zollo.

Good afternoon, Ron. I was hoping that you could comment on your dividend policy.

Where dividends are concerned, of course, this is a decision of the Board of Directors, as we address it every year and every quarter. But I should say that dividends have been an important part of our return to shareholders I know. And I know shareholders have looked at it that way, and we have looked at it that way ourselves, and dividends is one of those things that we think are very important to our future. But of course the decisions each time will have to be up to the Board of Directors. And in fact we should be making our next dividend declaration decision in our November board meeting coming up in a couple of weeks.

And then in regards to this mineral oil cost escalation, can you give me an idea as to the magnitude of your cost of goods?

Well, mineral oil alone accounts for about 15% of our cost of goods or raw material buy -- I guess is a more accurate way to put it. There are other derivatives of crude, though, that probably account for another 20% or so of our raw material buy. Does that help you at all?

It does. Thanks, guys.

(OPERATOR INSTRUCTIONS)

Okay, folks, I don't want to keep anybody unnecessarily. I appreciate your interest, and I'm glad we've been able to report to you I think a pretty positive third quarter for us, and I look forward to reporting a good end of the year when we get together next time. Thanks very much.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.